mcs april 2011 paper

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MCSFriday, April 22, 2011

all 40 to 93

Q.3) Which management control practices, if followed, in performance measurement of investment centres

are likely to induce goal congruence, in respect of following assets

a.(i) Idle (ii) Intangible (iii) Leased

b.(i) Cash (ii) Receivables (iii) Inventories

Ans. In some business units, the focus is on profit as measured by the difference between revenues and expenses. Inother business units, profit is compared with the assets employed in earning it. We refer to the latter group of

responsibility centers as investment centers.

Measuring Assets Employed

In deciding what investment base to use to evaluate investment center managers, headquarters asks two questions:

First, what practices will induce business unit managers to use their assets most efficiently and to acquire the proper

amount and kind of new assets? Presumably, when their profits are related to assets employed, business unit

managers will try to improve their performance as measured in this way. \Senior management wants the actions that

they take toward this end to be in the best interest of the whole corporation. Second, what practices best measure the

performance of the unit as an economic entity?

Cash

Most companies control cash centrally because central control permits use of a smaller cash balance than would be

the case if each business unit held the cash balances it needed to weather the unevenness of its cash inflows and

outflows. Business unit cash balances may well be only the "float" between daily receipts and daily disbursements.

Consequently, the actual cash balances at the business unit level tend to be much smaller than would be required if

the business unit were an independent company. Many companies therefore use a formula to calculate the cash to be

included in the investment base. For example, General Motors was reported to use 4.5 percent of annual sales; Du

Pont was reported to use two months' costs of sales minus depreciation.

One reason to include cash at a higher amount than the balance carried by a business unit is that the higher amount is

necessary to allow comparisons to outside companies. If only the actual cash were shown: by internal units would

appear abnormally high and might mislead senior management.

Some companies omit cash from the investment base. These companies reason that the amount of cash approximates

the current liabilities; if this is so, the sum of accounts receivable and inventories will approximate the working

capital.

Receivables
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Business unit managers can influence the level of receivables, not only indirectly by their ability to generate

sales, and directly, by establishing credit terms by approving individual credit accounts and credit limits, and

by the collecting overdue amount. In the interest of simplicity, receivable included at the actual end-.of-

period balances, although the average of intraperiod balances is conceptually a better measure of the am

should be related to profits.

Whether to include accounts receivable at selling prices or at cost of goods sold is debatable. One could arguethat the business unit's real investment in accounts receivable is only the cost of goods sold and that a

satisfactory return on this investment is probably enough. On the other hand, it is possible to argue that the

business unit could reinvest the money collected from accounts receivable, and, therefore, accounts receivable

should be included at selling prices. The usual practice is to take the simpler alternative-that is, receivables at

the book amount, which is the selling price less an allowance for bad debts.

If the business unit does not control credits and collections, receivables may be calculated on a formula basis.

This formula should be consistent with the normal payment period-for example, 30 days' sales where payment

is made 30 days after the shipment of goods.

Inventories

Inventories ordinarily are treated in a manner similar to receivables that is they are often recorded at end-of-period amounts even though intraperiod averages would be preferable conceptually. If the company uses LIFO

(last in first out) for financial accounting purposes, a different valuation method usually is used for business

unit profit reporting because LIFO inventory balances tend to be unrealistically low in periods of inflation. In

these circumstances, inventories should be valued at standard or average costs, and these same costs should be

used to measure cost of sales on the business unit income statement

If work-in-process inventory is financed by advance payments or byprogress payments from the customer, as is

typically the case with goods that require a long manufacturing period, these payments either are subtracted from the

gross inventory amounts or reported as liabilities.

For e.g. with manufacturing periods a year or greater, Boeing received progress payments for itsairplanes and recorded them as liabilities.

Some companies subtract accounts payable from inventory on the grounds that accounts payable represent financing

of part of the inventory by vendors, at zero cost to the business unit. The corporate capital required for inventories is

only the difference between the gross inventory amount and accounts payable. If the business unit can influence the

payment period allowed by vendors, then including accounts payable in the calculation encourages the manager to

seek the most favorable terms. In times of high interest rates or credit stringency, managers might be encouraged to

consider forgoing the cash discount to have, in effect, additional financing provided by vendors. On the other hand,

delaying payments unduly to reduce net current assets may not be in the company's best interest since this may hurt

its credit rating.

Leased Assets

Suppose the business unit whose financial statements are shown in Exhibit 1 (see page 21) sold its fixed assets for

their book value of $300,000, returned the proceeds of the sale to corporate headquarters, and then leased back the

assets at a rental rate of $60,000 per year. As Exhibit 2 (see page 21) shows, the business unit's income before taxes

would decrease because the new rental expense would be higher than the depreciation charge that was eliminated.

Nevertheless, economic valued added would increase because the higher cost would be more than offset by the

decrease in the capital charge. Because of this, business unit managers are induced to lease, rather than own, assets


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whenever the interest charge that is built into the rental cost is less than the capital charge that is applied to the

business unit's investment base. (Here, as elsewhere, this generalization oversimplifies because, in the real world,

the impact of income taxes must also be taken into account.)

Many leases are financing arrangements-that is, they provide an alternative way of getting to use assets that

otherwise would be acquired by funds obtained from debt and equity financing. Financial leases (i.e., long-termleases equivalent to the present value of the stream of lease charges) are similar to debt and are so reported on the

balance sheet. Financing decisions usually are made by corporate headquarters. For these reasons, restrictions

usually are placed on the business unit manager's freedom to lease assets.

Idle Assets

If a business unit has idle asset that can be used by other units, the business unit may be permitted to exclude them

from the investment base if it classifies them as available. The purpose of this permission is to encourage business

unit managers to release underutilized assets to units that may have better use for them. However, if the fixed assets

cannot be used by other units, permitting the business unit manager to remove them from the investment base could

result in dysfunctional actions For example; it could encourage the business unit manager to idle partially utilized

assets that are not earning a return equal to the business unit's profit objective. If there is no alternative use for the

equipment, any contribution from this equipment will improve company profits.

Intangible Assets

Some companies tend to be R&D intensive (e.g., pharmaceutical firms such as Novartis spend huge amounts on

developing new products); others tend to be marketing intensive (e.g., consumer products firms such as Unilever

spend huge amounts on advertising). There are advantages to capitalizing intangible assets such as R&D and

marketing and then amortizing them over a selected life. This method should change how the business unit manager

views these expenditures. By accounting for these assets as long-term investments, the business unit manager will

gain less short-term benefit from reducing out lays on such item, For instance, if R&D expenditures are expensed

immediately, each dollar of R&D cut would be a dollar more in pretax profits. On the other hand, if R&D costs are

capitalized, each dollar cut will reduce the assets employed by a dollar; the capital charge is thus reduced only by

one dollar times the cost of capital, which has a much smaller positive impact on economic valued added.

SET.6

Q.1) What do you understand by Goal Congruence? What are the informal factors that influence goal

congruence?

Ans: This term is used when the same goals are shared by top managers and their subordinates. This is one of the

many criteria used to judge the performance of an accounting system. The system can achieve its goal more

effectively and perform better when organizational goals can be well aligned with the personal and group goals of

subordinates and superiors. The goals of the company should be the same as the goals of the individual business

segments. Corporate goals can be communicated by budgets, organization charts, and job descriptions.

Goal Congruence- Meaning Individuals work in different hierarchies and handle different responsibilities &

may have different goals. But they must come together as far as Companys Goal is concerned (there action must

speak Cos language.)

Goal Congruence


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Example 1The HR manager has devised a HR training program to enhance the skills of its sales personnel, with an

objective to enhance their productivity But if company is in strategic need of attaining a certain sales volume in a

given quarter, it can not do so on account of non availability of personnel.

Example 2 The marketing department has planned an impressive advertising campaign, which promises good

returns, But say due to cash crunch Companys current financial position may not let to lose the strings

Example 3Production Manager may get a good applause for reducing cycle time; But at what cost? Building up

the high inventory i.e. higher investment in current assets. While doing so he just overlooked the financial interest of

the company. After completing the given activity in more efficient manner the concerned manager scores the

point/s on his score card. Whether his actions are leading to scoring of points on the organizations score card too?

if it is so then only one can say the organization is marching towards a common goal.

Every individual working in an organization has got his own motive to do the work. Individuals act in their own

interest, based on their own motivations. And it is always not necessarily consistent with the Cos goal. In a goal

congruence process, the actions the people are led to take in accordance with their perceived self interest are also in

the best interest of the organization i.e. Goal congruence ensures that the action of manager taken in their best

interest is also in the best interest of the organization.

Informal factors that influence goal congruence:

Informal Factors

External factorsset of attitudes of the society, work ethics of the society

Internal factors(Factors within the organization)

Culture-Common beliefs, shared values, norms of behavior & assumptions

Implicitly accepted and explicitly built into.

Mgt. StyleInformal/Formal

The Communication Channels

Perception and Communicatione.g. Budget (meaning) strict profit.

Organizations with Business Divisions (Profit Centre) format have observed that Divisional Controllers

experience divided loyalty in carrying out their functions, causing a possible dysfunction. How could such a

situation be resolved? Define role of controller which suits your suggestion.

To the extent the decision are decentralized top management may lose some control. Relying on control reports is

not as effective as personal knowledge of an operation. With profit center, top management must change its

approach to control. Instead of personal direction senior management must rely to a considerable extent on

management control reports.

Competent units that were once cooperating as functional units may now compete with one another disadvantageously. An increase in one managers profit may decrease those of another. This decrease in cooperation

may manifest itself in a manager unwillingness to refer sales lead to another business unit, even though that unit is

better qualified to follow up on the lead in production decision that have undesirable cost consequence on other units

or in the hoarding of personnel or equipment that from the overall company standpoint would be better off used in

another units.


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There may be too much emphasis on short run profitability at the expense of long run profitability. In the desire to

report high current profits, the profit center manager may skip on R&D, training, maintenance. This tendency is

especially prevalent when the turnover of profit center managers is relatively high. In these circumstances, manager

may have good reason to believe that their action may not affect profitability until after they have moved to other

job.

There is no complete satisfactory system for ensuring that each profit center by optimizing its own profit , will

optimize company profits.

If headquarter management is more capable or has better information then the average profit center manager the

quality of some of the decision may be reduced.

Divisionalization may cause additional cost because it may require additional management staff personnel and

recordkeeping and may lead to redundant at each profit center.

Business units as profit centers:

Business units are usually set up at profit centers. Business unit managers tend to control product development,

manufacturing, and marketing resources. They are in a position to influence revenue and cost and as such can be

held accountable for the bottom line. However as pointed out in the next section a business unit manager authority

may be constrained such constrained should be incorporated in designing and operating profit center.

Constraint on business unit authority

To realize fully the advantage of the profit center concept the business unit manger would have to be as autonomous

as the president of the independent company. As a practical matter however such autonomy is not feasible. If a

company were divided into completely independent units the organization would be giving up the advantage of size

and synergism. Also senior management authority that a board of director gives to the chief executive. Consequently

business unit structure represents trade off between business unit autonomy and corporate constraint. The

effectiveness of a business units organization is largely dependent on how well these trade off are made.

The performance of a profit center is appraised by comparing actual results for one or more orf these measures withbudgeting amounts. In addition, data on competitors and the industry provide a good cross check on the appropriate

of the budget. Data for individual companies are available from the securities and exchange commission for about

key business ratios; standard & poor computer services, Inc; Robert Morris associates annual statement studies; and

annual survey published in fortune, business week, and Forbes. Trade associations publish data for the companies in

their industries.

Revenues: choosing the appropriate revenue recognition method is important. Should revenue be recognized at the

time as order is received, at the time an order is shipped, or at the time cash is received?

In addition to that decision, issues related to common revenues may need to be considered. There are some

situations in which two or more profit centers participate in the sales effort that results in a sale; ideally, each should

be given appropriate credit for its part in this transaction. Many companies have not given much attention to thesolution of these common revenue problems. They take the position that the identification of price responsibility for

revenue generation is too complicated to be practical and that sale personnel must recognize they are working not

only for their own profit center but also for the overall good of the company. They for example, may credit the

business unit that takes an order for a product handled by the another unit with the equivalent of a brokerage

commission or a finder fee. In the case of a bank the branch performing a service may be given explicit credit for

that service even though the customer account is maintained in another branch.


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Role of controller

It should publish procedure and forms for the preparation of the budget.

It should provide assistance to budgetees in the preparation of their budget.

It should administer the process of making budget revision during the year.

It should coordinate the work of budget departments in lower echelons

It should analyze reported performance against budget, interprets the result, and prepares summary report for

senior management.

Part of a multinational group, Sundaram Shoe Company(SSC), established its own facilities in India

over 75 years ago and enjoyed an excellent record-high market share for its diverse range of shoes,

growth and profits. SC markets its products through company owned shops and its own personnel.

Organization structure is functional. Since 2001, profitability, market share are slipping. Pressure

from cheap Chinese shoes and also premium shoes like Nike has made the company think< of

organizational restructuring and introducing Comensurate Control System to regain its position.

Although SSC outsources, 30% of products, it is seen as a production oriented company. SSC wants toadopt measures to reduce costs, strengthen marketing and be in a position to produce and meet

unexpected and unusual customer demands. How should the company reorganize to achieve Goal

Congruence. Define Performance Metric?

In a goal congruent process, the actions people are led to take in accordance with their perceived self-interest are

also in the best interest of the organization. A firms strategy has a major influence on its structure. The type of

structure in turn influences the design of the organizations management control systems. Sundaram Shoe

Companys (SSC) organization structure is functional which involves the notion of a manager who brings

specialized knowledge to bear on decisions related to a specific function, vis--vis a general purpose manager who

lacks the specialized knowledge. A skilled marketing and production manager would be able to make better

decisions in their respective fields. He would also be able to supervise workers in the same function better than the

generalist would. Thus an important advantage of the functional structure is efficiency. A major disadvantage of this

structure is that there is no unambiguous way of determining the effectiveness of the separate functional managers

because each function contributes jointly to the organizations final output. Therefore, there is no way of

determining how much of the profit was earned respectively by the several production departments.

Sundaram Shoe Company which was a market leader for a period of over 75 years has been losing market share,

which has impacted its profitability. Also it needs to be seen that the company outsources about 30% of its products.

The company aims to strengthen marketing, reduce costs and wants to be in a position to customize products as per

the demands of the customer. Thus, Sundaram needs to re-organize its organization structure which is functional to a

Business Unit form of organization. The benefits of the re-organization would be that the business unit or the

division would be responsible for all the functions involved in producing and marketing a specified product line.

The business managers act almost as if their units are separate companies. They are responsible for planning and co-

coordinating the work of the separate functions. Their performance is measured by the profitability of the business

unit. This is a valid criterion because profit reflects the activities of both marketing and production.

Though business unit managers exercise broad authority over their units, headquarters reserves certain key

prerogatives. Headquarters are responsible for obtaining funds for the company as a whole and allocating it to the

business unit, as well as approving budgets and judging the performance of business unit managers, setting their

compensation.


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A major advantage of the Business unit structure of organization is that because it is close to the market for its

products than the headquarters, its manager may make sounder production and marketing decisions than

headquarters might and the unit as a whole reacts to new threats or opportunities quickly. This re-organization

would help in achieving goal congruence in the organization.

Performance Metrics are high-level measures whatyou are doing; that is, they assess your overall performance in

the areas you are measuring. They are external in nature and are most closely tied to outputs, customer requirements,

and business needs for the process.

The performance measurement system should cover the following areas at a minimum:

CUSTOMERS

1. Performance against customer requirements

2. Customer Satisfaction

PERFORMANCE OF INTERNAL WORK PROCESSES

1. Cycle times

2. Product and service quality

3. Cost performance (could be productivity measures, inventory, etc.)

SUPPLIERS

1. Performance of suppliers against your requirements

FINANCIAL

1. Profitability (could be at the company, product line, or individual level)

2. Market share growth and other standard financial measures

EMPLOYEE1. Associate satisfaction

SET .7

Q: 1) (A) Describe the factors which impact service organization

Ans: Factors which impact service organization:

Absence of Inventory Buffer:

Goods can be held as inventory, which is a buffer that dampens the impact on production activity of fluctuations in

sales volume. Services cannot be stored. The airplane seat, hotel room, hospital operating room, or the hours of

lawyers, physicians, scientists, and other professionals that are not used today are gone forever. Thus, although a

manufacturing company can earn revenue in the future from products that are on hand today, a service company

cannot do so. It must try to minimize its unused capacity.

Moreover, the costs of many service organizations are essentially fixed in the short run. In the short run, a hotel

cannot reduce its costs substantially by closing off some of its rooms. Accounting firms, law firms, and other


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professional organizations are reluctant to layoff professional personnel in times of low sales volume because of the

effect on morale and the costs of rehiring and training.

Difficulty in Controlling Quality:

A manufacturing company can inspect its products before they are shipped to the consumer, and their quality can be

measured visually or with instruments (tolerances, purity, weight, color, and so on). A service company cannotjudge product quality until the moment the service is rendered, and then the judgments are often subjective.

Restaurant management can examine the food in the kitchen, but customer satisfaction depends to a considerable

extent on the way it is served. The quality of education is so difficult to measure that few educational organizations

have a formal quality control system.

Labor Intensive:

Manufacturing companies add equipment and automate production lines, thereby replacing labor and reducing costs.

Most service companies are labor intensive and cannot do this. Hospitals do add expensive equipment, but mostly to

provide better treatment, and this increases costs. A law firm expands by adding partners and new support personnel.

Multi-Unit Organizations:

Some service organizations operate many units in various locations; each unit relatively small. These organizations

are fast-food restaurant chains, auto rental companies, gasoline service stations, and many others. Some of the units

are owned; others operate under a franchise. The similarity of the separate units provides a common basis for

analyzing budgets and evaluating performance not available to the manufacturing company. The information for

each unit can be compared with system wide or regional averages, and high performers and low performers can be

identified. However because units differ in the mix of services they provide, in the resources that they use, and in

other ways, care must be taken in making such comparisons.

Q:1) (B) Explain special characteristics of professional organization which would have a bearing on their

control system.

Ans: Special Characteristics of Professional Organization:

Goals:

A dominant goal of a manufacturing company is to earn a satisfactory profit, specifically a satisfactory return on

assets employed. A professional organization has relatively few tangible assets; its principal asset is the skill of its

professional staff, which doesn't appear on its balance sheet. Return on assets employed, therefore, is essentially

meaningless in such organizations. Their financial goal is to provide adequate compensation to the professionals.

In many organizations, a related goal is to increase their size. In part, this reflects the natural tendency to associate

success with large size. In part, it reflects economies of scale in using the efforts of a central personnel staff andunits responsible for keeping the organization up to- date. Large public accounting firms need to have enough local

offices to enable them to audit clients who have facilities located throughout the world.

Professionals:

Professional organizations are labor intensive, and the labor is of a special type. Many professionals prefer to work

independently, rather than as part of a team. Professionals who are also managers tend to work only part time on

management activities; senior partners in an accounting firm participate actively in audit engagements; senior


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partners in law firms have clients. Education for most professions does not include education in management, but

quite naturally stresses the skills of the profession, rather than management; for this and other reasons, professionals

tend to look down on managers. Professionals tend to give inadequate weight to the financial implications of their

decisions; they want to do the best job they can, re- I regardless of its cost. This attitude affects the attitude of

support staffs and nonprofessionals in the organization; it leads to inadequate cost control.

Output and Input Measurement:

The output of a professional organization cannot be measured in physical terms, such as units, tons, or gallons. We

can measure the number of hours a lawyer spends on a case, but this is a measure of input, not output. Output is the

effectiveness of the lawyer's work, and this is not measured by the number of pages in a brief or the number of hours

in the courtroom. We can measure the number of patients a physician treats in a day, and even classify these visits

by type of complaint; but this is by no means equivalent to measuring the amount or quality of service the physician

has provided. At most, what is measured is the physician's efficiency in treating patients, which is of some use in

identifying slackers and hard workers. Revenues earned is one measure of output in some professional

organizations, but these monetary amounts, at most, relate to the quantity of services rendered, not to their quality

(although poor quality is reflected in reduced revenues in the long run).

Furthermore, the work done by many professionals is non repetitive. No two consulting jobs or research and

development projects are quite the same. This makes it difficult to plan the time required for a task, to set reasonable

standards for task performance, and to judge how satisfactory the performance was. Some tasks are essentially

repetitive: the drafting of simple wills, deeds, sales contracts, and similar documents; the taking of a physical

inventory by an auditor; and certain medical and surgical procedures. The development of standards for such tasks

may be worthwhile, although in using these standards, unusual circumstances that affect a specific job must be taken

into account.

Small Size:

With a few exceptions, such as some law firms and accounting firms, professional organizations are relatively small

and operate at a single location. Senior management in such organizations can personally observe what is going on

and personally motivate employees. Thus, there is less need for a sophisticated management control system, with

profit centers and formal performance reports. Nevertheless, even a small organization needs a budget, a regular

comparison of performance against budget, and a way of relating compensation to performance.

Marketing:

In a manufacturing company there is a clear dividing line between marketing activities and production activities;

only senior management is concerned with both. Such a clean separation does not exist in most professional

organizations. In some, such as law, medicine, and accounting, the profession's ethical code limits the amount and

character of overt marketing efforts by professionals (although these restrictions have been relaxed in recent years).

Marketing is an essential activity in almost all organizations, however. If it can't be conducted openly, it takes theform of personal contacts, speeches, articles, conversations on the golf course, and so on. These marketing activities

are conducted by professionals, usually by professionals who spend much of their time in production work-that is,

working for clients.

In this situation, it is difficult to assign appropriate credit to the person responsible for "selling" a new customer. In a

consulting firm, for example, a new engagement may result from a conversation between a member of the firm and

an acquaintance in a company, or from the reputation of one of the firm's professionals as an outgrowth of speeches


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or articles. Moreover, the professional who is responsible for obtaining the engagement may not be personally

involved in carrying it out. Until fairly recently, these marketing contributions were rewarded subjectively- that is,

they were taken into account in promotion and compensation decisions. Some organizations now give explicit credit,

perhaps as a percentage of the project's revenue, if the person who "sold" the project can be identified.

Q:2) Every SBU is a profit center but every profit center is not a SBU? What are the conditions that shouldbe fulfill for an organization unit to be converted into a profit center? What are the different ways to measure

the performance of profit center? Discuss their relevant merits and demerits.

Ans: Conditions for an organization to be converted into a profit centre: Many management decisions involve

proposals to increase expenses with the expectation of an even greater increase in sales revenue. Such decisions are

said to involve expense/revenue trade-offs. Additional advertising expense is an example. Before it is safe to

delegate such a trade-off decision to a lower-level manager, two conditions should exist.

The manager should have access to the relevant information needed for making such a decision.

There should be some way to measure the effectiveness of the trade-offs the manager has made.

A major step in creating profit centers is to determine the lowest point in an organization where these two conditions

prevail. All responsibility centers fit into a continuum ranging from those that clearly should be profit centers to

those that clearly should not. Management must decide whether the advantages of giving profit responsibility offset

the disadvantages, which are discussed below. As with all management control system design choices, there is no

clear line of demarcation.

Ways to Measure Performance:

There are two types of profitability measurements used in evaluating a profit center, just as there are in evaluating an

organization as a whole. First, there is the measure of management performance, which focuses on how well the

manager is doing. This measure is used for planning, coordinating, and controlling the profit center's day-to-day

activities and as a device for providing the proper motivation for its manager. Second, there is the measure

of economic performance, which focuses on how well the profit center is doing as an economic entity. The messagesconveyed by these two measures may be quite different from each other. For example, the management performance

report for a branch store may show that the store's manager is doing an excellent job under the circumstances, while

the economic performance report may indicate that because of economic and competitive conditions in its area the

store is a losing proposition and should be closed. .

The necessary information for both purposes usually cannot be obtained from a single set of data. Because the

management report is used frequently, while the economic report is prepared only on those occasions when

economic decisions must be made, considerations relating to management performance measurement have first

priority in systems design-that is, the system should be designed to measure management performance routinely,

with economic information being derived from these performance reports as well as from other sources.

Types of Profitability Measures

A profit center's economic performance is always measured by net income (i.e., the income remaining after all costs,

including a fair share of the corporate overhead, have been allocated to the profit center). The performance of the

profit center manager, however, may be evaluated by five different measures of profitability: (1) contribution

margin, (2) direct profit, (3) controllable profit, (4) income before income taxes, or (5) net income

(1) Contribution Margin:


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Contribution margin reflects the spread between revenue and variable expenses. The principal argument in favor of

using it to measure the performance of profit center managers is that since fixed expenses are beyond their control,

managers should focus their attention on maximizing contribution. The problem with this argument is that its

premises are inaccurate; in fact, almost all fixed expenses are at least partially controllable by the manager, and

some are entirely controllable. Many expense items are discretionary; that is, they can be changed at the discretion

of the profit center manager. Presumably, senior management wants the profit center to keep these discretionaryexpenses in line with amounts agreed on in the budget formulation process. A focus on the contribution margin

tends to direct attention away from this responsibility. Further, even if an expense, such as administrative salaries,

cannot be changed in the short run, the profit center manager is still responsible for controlling employees'

efficiency and productivity.

(2) Direct Profit:

This measure reflects a profit center's contribution to the general overhead and profit of the corporation. It

incorporates all expenses either incurred by or directly traceable to the profit center, regardless of whether or not

these items are within the profit center manager's control. Expenses incurred at headquarters, however, are not

included in this calculation. A weakness of the direct profit measure is that it does not recognize the motivational

benefit of charging headquarters costs.

(3) Controllable Profit:

Headquarters expenses can be divided into two categories: controllable and non controllable. The former category

includes expenses that are controllable, at least to a degree, by the business unit manager-information technology

services, for example. If these costs are included in the measurement system, profit will be what remains after the

deduction of all expenses that may beinfluenced by the profit center manager. A major disadvantage of this measure

is that because it excludes non controllable headquarters expenses it cannot be directly compared with either

published data or trade association data reporting the profits of other companies in the industry.

(4) Income before Taxes:

In this measure, all corporate overhead is allocated to profit centers based on the relative amount of expense each

profit center incurs. There are two arguments against such allocations. First, since the costs incurred by corporate

staff departments such as finance, accounting, and human resource management are not controllable by profit center

managers, these managers should not be held accountable for them. Second, it may be difficult to allocate corporate

staff services in a manner that would properly reflect the amount of costs incurred by each profit center.

There are, however, three arguments in favor of incorporating a portion of corporate overhead into the profit centers'

performance reports. First, corporate service units have a tendency to increase their power base and to enhance theirown excellence without regard to their effect on the company as a whole. Allocating corporate overhead costs to

profit centers increases the likelihood that profit center manager will question these costs, thus serving to keep head

office spending in check. (Some companies have actually been known to sell their corporate jets because of

complaints from profit center managers about the cost of these expensive items.) Second, the performance of each

profit center will become more realistic and more readily comparable to the performance of competitors who pay for

similar services. Finally, when managers know that their respective centers will not show a profit unless all-costs,

including the allocated share of corporate overhead, are recovered, they are motivated to make optimum long-term


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marketing decisions as to pricing, product mix, and so forth, that will ultimately benefit (and even ensure the

viability of) the company as a whole.

If profit centers are to be charged for a portion of corporate overhead, this item should be calculated on the basis of

budgeted, rather than actual, costs, in which case the "budget" and "actual" columns in the profit center's

performance report will show identical amounts for this particular item. This ensures that profit center managers willnot complain about either the arbitrariness of the allocation or their lack of control over these costs, since their

performance reports will show no variance in the overhead allocation. Instead, such variances would appear in the

reports of the responsibility center that actually incurred these costs. .

(5) Net Income:

Here, companies measure the performance of domestic profit centers according to the bottom line, the amount of net

income after income tax. There are two principal arguments against using this measure: (1) after tax income is often

a constant percentage of the pretax income, in which case there would be no advantage in incorporating income

taxes, and (2) since many of the decisions that affect income taxes are made at headquarters, it is not appropriate to

judge profit center managers on the consequences of these decisions. There are situations, however, in which the

effective income tax rate does vary among profit centers. For example, foreign subsidiaries or business units with

foreign operations may have different effective income tax rates. In other cases, profit centers may influence income

taxes through their installment credit policies, their decisions on acquiring or disposing of equipment, and their use

of other generally accepted accounting procedures to distinguish gross income from taxable income. In these

situations, it may be desirable to allocate income tax expenses

to profit centers not only to measure their economic profitability but also to motivate managers to minimize tax

liability.

Merits:

The quality of decisions may improve because they are being made by managers closest to the point of

decision.

The speed of operating decisions may be increased since they do not have to be referred to corporate

headquarters. . Headquarters management, relieved of day-to-day decision making, can concentrate on broader

issues.

Managers, subject to fewer corporate restraints, are freer to use their imagination and initiative.Because

profit centers are similar to independent companies, they provide an excellent training ground for general

management. Their managers gain experience in managing all functional areas, and upper management gains the

opportunity to evaluate their potential for higher-level jobs.

Profit consciousness is enhanced since managers who are responsible' for profits will constantly seek ways

to increase them. (A manager responsible for marketing activities, for example, will tend to authorize promotionexpenditures that increase sales, whereas a manager responsible for profits will be motivated to make promotion

expenditures that increase profits.).

Profit centers provide top management with ready-made information on theprofitability of the company's

individual components. . Because their output is so readily measured, profit centers are particularly responsive to

pressures to improvetheir competitive performance.

Demerits:


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Decentralized decision making will force top management to rely more on management control

reports than on personal knowledge of an operation, entailing some loss of control.

If headquarters management is more capable or better informed than the average profit center

manager, the quality of decisions made at the unit level may bereduced.

Friction may increase because of arguments over the appropriate transfer price, the assignment of

common costs, and the credit for revenues that were formerly generated jointly by two or morebusiness units working together.

Organization units that once cooperated as functional units may now be incompetition with one

another. An increase in profits for one manager may mean a decrease for another. In such

situations, a manager may fail to refer sales leads to another business unit better qualified to

pursue them; may hoard personnel or equipment that, from the overall company standpoint,

would be better off used in another unit; or may make production decisions that have undesirable

cost consequences for other units.

Divisionalization may impose additional costs because of the additional management, staff

personnel, and record keeping required, and may lead to task redundancies at each profit center.

Q:3) what are different types of Strategic Missions at SBU level? How do these missions affect StrategicPlanning process and Budgeting at SBU Level?

Different Types of Strategic Missions:

Business Unit Mission:

In a diversified firm one of the important tasks of senior management is resource deployment, that is, make

decisions regarding the use of the cash generated from some business units to finance growth in other business units.

Several planning models have been developed to help corporate level managers of diversified firms to effectively

allocate resources. These models suggest that a firm has business units in several categories, identified by their

mission; the appropriate strategies for each category differ. Together, the several units make up a portfolio, thecomponents of which differ as to their risk/reward characteristics just as the components of an investment portfolio

differ. Both the corporate 'office and the business unit general manager are involved in identifying the missions of

individual business units. Of the many planning models, two of the most widely used are Boston Consulting Group's

two-by-two growth-share matrix and General Electric Company/McKinsey & Company's three-by-three industry

attractiveness-business strength matrix. While these models differ in the methodologies they use to develop the most

appropriate missions for the various business units, they have the same set of missions from which to choose: build,

hold, harvest, and divest.

Build: This mission implies an objective of increased market share, even at the expense of short-termearnings

and cash flow (e.g., Merck's bio-technology, Black and Decker's handheld electrictools).

Hold: This strategic mission is geared to the protection of the business unit's market share and competitive

position (e.g.: IBM's mainframe computers).Harvest: This mission has the objective of maximizing short-term earnings and cash flow, even at the expense of

market share (e.g., American Brands' tobacco products, General Electric's and Sylvania's light bulbs)

Divest: This mission indicates a decision to withdraw from the business either through a process of slow

liquidation or outright sale. While the planning models can aid in the formulation of missions, they are not cook

books. A business unit's position on a planning grid should not be the sole basis for deciding its mission.


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Business Unit Competitive Advantage: Every business unit should develop a competitive advantage in order to

accomplish its mission. Three interrelated questions have to be considered in developing the business unit's

competitive= advantage. First, what is the structure of the industry in which the business unit operates? Second, how

should the business unit exploit the industry's structure? Third, what will be the basis of the business unit's

competitive advantage?

Industry Analysis: Research has highlighted the important role industry conditions play in the performance ofindividual firms. Studies have shown that average industry profitability is, by far, the most significant predictor of

firm performance. According to Porter, the structure of an industry should be analyzed in terms of the collective

strength of five competitive forces.

1. The intensity of rivalry among existing competitors. Factors affecting direct rivalry are industry growth, product

differentiability, number and diversity of competitors, level of fixed costs, intermittent overcapacity, and exit

barriers.

2. The bargaining power of customers. Factors affecting buyer power are number of buyers, buyer's switching costs,

buyer's ability to integrate backward, impact of the business unit's product on buyer's total costs, impact of the

business unit's product on buyer's product quality/ performance, and significance of the business unit's volume to

buyers.

3. The bargaining power of suppliers. Factors affecting supplier power are number of suppliers, supplier's ability to

integrate forward, presence of substitute inputs, and importance of the business unit's volume to suppliers.

4. Threat from substitutes. Factors affecting substitute threat are relative price/performance of substitutes, buyer's

switching costs, and buyer's propensity to substitute.

5. The threat of new entry. Factors affecting entry barriers are capital requirements, access to distribution channels,

economies of scale, product differentiation, technological complexity of product or process, expected retaliation

from existing firms, and government policy.

We make three observations with regard to the industry analysis:

1. The more powerful the five forces are, the less profitable an industry is likely to be. In industries where average

profitability is high (such as soft drinks and pharmaceuticals), the five forces are weak (e.g., in the soft drink

industry, entry barriers are high). In industries where the average profitability is low (such as steel and coal), the five

forces are strong (e.g., in the steel industry, threat from substitutes is high).

2. Depending on the relative strength of the five forces, the key strategic issues facing the business unit will differ

from one industry to another.

3. Understanding the nature of each force helps the firm to formulate effective strategies. Supplier selection (a

strategic issue) is aided by the analysis of the relative power of several supplier groups; the business unit should link

with the supplier group for which it has the best competitive advantage. Similarly, analyzing the relative bargaining

power of several buyer groups will facilitate selection of target customer segments.

Generic Competitive Advantage:


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The five-force analysis is the starting point for developing a competitive advantage since it helps to identify the

opportunities and threats in the external environment. With this understanding, Porter claims that the business unit

has two generic ways of responding to the opportunities in the external environment and developing a sustainable

competitive advantage: low cost and differentiation.

Low Cost: Cost leadership can be achieved through such approaches as economies of scale in production;

experience curve effects, tight cost control, and cost minimization (in such areas as research and development,service, sales force, or advertising). Some firms following this strategy include Charles Schwab in discount

brokerage, Wal-Mart in discount retailing, Texas Instruments in consumer electronics, Emerson Electric in electric

motors, Hyundai in automobiles, Dell in computers, Black and Decker in machine tools, Nucor in steel, Lincoln

Electric in arc welding equipment, and BIC in pens.

Differentiation:

The primary focus of this strategy is to differentiate the product offering of the business unit, creating something

that is perceived by customers as being unique. Approaches to product differentiation include brand loyalty (Coca-

Cola and Pepsi Cola in soft drinks), superior customer service (Nordstrom in retailing), dealer network (Caterpillar

Tractors in construction equipment), product design and product features (Hewlett-Packard in electronics), and

technology (Cisco in communications infrastructure). Other examples of firms following a differentiation strategy

include BMW in automobiles; Stouffer's in frozen foods, Neiman-Marcus in retailing, Mont Blanc in pens, and

Rolex in wristwatches.

Value Chain Analysis:

Business units can develop competitive advantage based on low cost, differentiation, or both. The most attractive

competitive position is to achieve cost-cum-differentiation.

SET 8

1.What is a responsibility centre? List and explain different types of Responsibility Centers with sketches.

Responsibility centers:

A responsibility center is an organization unit that is headed by a manager who is responsible for its activities. In asense, a company is a collection of responsibility centers. Each of which is represented by box on the on theorganization are responsibility centers for section work shifts or other small organization units. At a higher level aredepartments or business units that consist of several of these smaller units plus staff and management people theselarger units are also responsibility center. And from the stand point of senior management and the board of directors,the whole company is responsibility center although the term is usually used to refer to unit within the company.

Nature of responsibility centers


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A responsibility center exist one or more purpose are its objectives. The company as a whole has goals, and seniormanagement has decided on a set of strategies to accomplish these goals. The objectives of responsibility centers areto help implement these strategies. Because the organization is the sum of its responsibility centers, if the strategiesare sound and if each responsibility center, if the strategies are sound and if each responsibility center meets itsobjectives the whole organization should achieve its goals. A responsibility center uses inputs, and a variety ofservices. Its work with these resources and it usually require working capital, equipment, and other asset to do thiswork. As a result of this work the responsibility center produces output which is classified either as goods if they aretangible or as services if they are intangible. Every responsibility center has output that is it does something. In aproduction plant, the outputs are goods. In staff units, such as human resources, transportation, engineering,accounting, and administration, the output s are services. For many responsibility centers, especially staff units,outputs are difficult to measure; nevertheless, they exist. The products produced by a responsibility center or to theoutside marketplace. In the first case, the product are inputs to the other responsibility center in the latter case, theyare output s of the whole organization.

Types of Responsibility Centers

Cost Center

Cost centers are divisions that add to the cost of the organization, but only indirectly add to the profit of

the company. Typical examples include Research and Development, Marketing and Customer service.Companies may choose to classify business units as cost centers, profit centers, or investment centers.There are some significant advantages to classifying simple, straightforward divisions as cost centers,since cost is easy to measure. However, cost centers create incentives for managers to underfund theirunits in order to benefit themselves, and this underfunding may result in adverse consequences for thecompany as a whole (reduced sales because of bad customer service experiences, for example).Because the cost centre has a negative impact on profit (at least on the surface) it is a likely target forrollbacks and layoffs when budgets are cut. Operational decisions in a contact centre, for example, aretypically driven by cost considerations. Financial investments in new equipment, technology and staff areoften difficult to justify to management because indirect profitability is hard to translate to bottom-linefigures. Business metrics are sometimes employed to quantify the benefits of a cost centre and relatecosts and benefits to those of the organization as a whole. In a contact centre, for example, metrics suchas average handle time, service level and cost per call are used in conjunction with other calculations to

justify current or improved funding.

Profit Center

A responsibility centre is called a profit centre when the manager is held responsible for both costs (inputs) andrevenues (outputs) and thus for profit. Despite the name, a profit centre can exist in nonprofits organizations (thoughit might not be referred to as such) when a responsibility centre receives revenues for its services. A profit centre is abig segment of activity for which both revenues and costs are accumulated: A centre, whose performance ismeasured in terms of both - the expense it incurs and revenue it earns, is termed as a profit centre. The output of aresponsibility centre may either be meant for internal consumption or for outside customers. In the latter case, therevenue is realized when the sales are made. That is, when the output is meant for outsiders, then the revenue will bemeasured from the price charged from customers. If the output is meant for other responsibility centre, then


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management takes a decision whether to treat the centre as profit centre or not. In fact, any responsibility centre canbe turned into a profit centre by determining a selling price for its outputs. For instance, in case of a processindustry, the output of one process may be transferred to another process at a profit by taking into account themarket price. Such transfers will give some profit to that responsibility centre. Although such transfers do notincrease the Companys assets, they help in management control process.

Investment Centre

An investment centre goes a step further than a profit centre does. Its success is measured not only by its income butalso by relating that income to its invested capital, as in a ratio of income to the value of the capital employed. Inpractice, the term investmentcentreis not widely used. Instead, the term profitcentreis used indiscriminately to

describe centers that are always assigned responsibility for revenues and expenses, but may or may not be assignedresponsibility for the capital investment. It is defined as a responsibility centre in which inputs are measured in termsof cost / expenses and outputs are measured in terms of revenues and in which assets employed are also measured. Aresponsibility centre is called an investment centre, when its manager is responsible for costs and revenues as well asfor the investment in assets used by his centre. He is responsible for maintaining a satisfactory return on investmenti.e. asset employed in his responsibility centre. The investment centre manager has control over revenues, expensesand the amounts invested in the centres assets. The manager of an investment centre is required to earn asatisfactory return. Thus, return on investment (ROI) is used as the performance evaluation criterion in aninvestment centre. He also formulates the credit policy, which has a direct influence on debt collection, and theinventory policy, which determines the investment in inventory. The Vice President (Investments) of a mutual fundscompany may be in charge of an Investment Centre. In the Investment Centre, the manager in charge is heldresponsible for the proper utilization of assets. He is expected to earn a satisfactory return on the assets employed inhis responsibility centre. Measurement of assets employed poses many problems. It becomes difficult to determinethe amount of assets employed in a particular responsibility centre. Some of the assets are in the physical possessionof the responsibility centre while for some assets it may depend upon other responsibility centers or the Head Officeof the company. This is particularly true of cash or heavy plant and equipment. Whether such assets should beincluded in the figure of assets employed of the responsibility centre and if included, at how much value, is adifficult question. On account of these difficulties, investment centers are generally used only for relatively largeunits, which have independent divisions, both manufacturing and marketing, for their individual products.

2.Explain the process of evaluation of Responsibility Center from one stage to another with the help of

illustration-cum-experiences of the corporate.

Process of evaluation of Responsibility Center.


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1. The organization is divided into various responsibility centers. Each responsibility centre is putunder the charge of a responsibility manager.2. The targets or budgets of each responsibility centre are set in consultation with the manager ofresponsibility centre, so that he may be able to give full information about his department. The managerof responsibility centre should know as what is expected of him - each centre should have a clear set ofgoals. The responsibility and authority of each centre should be well defined.3. Managers are charged with the items and responsibility, over which they can exercise a significantdegree of direct control.4. Goals defined for each area of responsibility should be attainable with efficient and effectiveperformance.5. The actual performance is communicated to the managers concerned. If it falls short of thestandards, the variances are conveyed to the top management. The names of persons responsible for thevariances are also conveyed so that responsibility may be fixed.

The purpose of all these steps is to assign responsibility to different individuals so that their performance isimproved and costs are controlled. The personal factor in Responsibility Accounting is most important. Themanagement may prepare the best plan or the budget and put up before its staff, but its success depends upon theinitiative and the will of the workers to execute it

Example of Responsibility Center

The Sarva Shiksha Abhiyan emphasizes quality improvement in elementary education for which it deems necessarythat resource groups and responsibility centers from national to sub-district levels are identified. These groups wouldoversee the policy, planning, implementation and monitoring of all quality related interventions. Their major rolewould be to advise and assist at various levels in curriculum development, pedagogical improvement, teachereducation/training and activities related to classroom transaction. In order to facilitate a decentralized mode ofeducation, these groups would need to be constituted at various operational levels, namely - national, state, districtand sub district. The following could be involved in the groups:

National level - NCERT, NIEPA, Universities, NGOs, experts and eminent educationists.

State level - SCERT, SIEMAT, Universities, IASEs/CTEs, NGOs, experts and eminent educationists.

District level - DIETs, representatives from DPEP District Resource Group, higher educational institutions,innovative teachers from the districts, NGOs.

Sub-district - BRC/BEO, representatives from CRCs, innovative teachers.

3.Briefly define Discretionary Expense Center, Engineered Expense Center, Profit Centre and Investment

Centre? How is budget prepared in Discretionary Expenses Centre?

Engineered expense centers:

Engineered expense center have the following characteristics:

- Their inputs can be measured in monetary terms.

- Their output can be measured in physical terms.

- The optimal dollar amount of input required to produce one unit of output can be established.


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Engineered expense center usually are found in manufacturing operations. Warehousing, distribution, trucking andsimilar units in the marketing organization also may be engineered expense center and so many certainresponsibility center within administrative and support department. Examples are accounts receivable accountpayable and payroll section in the controller department personnel record and cafeteria in the human resourcedepartment shareholder record in the corporate secretary department and the company motor pool. Such unitsperform repetitive task for which standard cost can be developed. In an engineered expense center the outputmultiplied by the standard cost of each unit produced represents what the finished product should have cost. Whenthis cost is compared to actual costs, the difference between the two represents the efficiency of the organization unitbeing measured. We emphasize that engineered expense centers have other important tasks not measured by castalone. The effectiveness of this aspect of performance should be controlled. For example expenses center supervisorare responsible for the quality of good and for the volume of production in addition to their responsibility for costefficiency. Therefore the type and amount of production is prescribed and specific quality standards are set so thatmanufacturing costs are not minimized at the expense of quality. Moreover manager of engineered expense centermay be responsible for activities such a training that are not related to current production judgment about theirperformance should include an appraisal of how well they carry out these responsibilities. There are few if anyresponsibility center in which all cost items are engineered. Even in highly automated production department theamount of indirect labor and of various services used can vary with management discretion. Thus, the termengineered costs center refers to responsibility center in which engineered cost predominate but in does not implythat valid engineering estimates can be made for each and every cost item.

Discretionary expense center:

The output of discretionary expenses center cannot be measured in monitory terms. They include administration andsupport units research and development organization and most marketing activities. The term discretionary does notmean that management judgment is capricious or haphazard. Management has decided on certain policies thatshould govern the operation of the company. Whether to match exceed or spend less than the marketing effort of itscompetitor; the level of service that the company provides to the customer. The appropriate amount of spending forR & D, financial planning public relation and many other activities. One company may have a small headquarterstaff another company of similar size and in the same industry may have a staff that is 10 times as large. themanagement of both companies may be concerned that they made the correct decision on staff size but there is noobjective way judging which decision was actually better manager are hired and paid to make such decision. Aftersuch a drastic change the level of discretionary expenses generally has a similar pattern from one year to the next.The difference between budgeted and actual expense is not a measure of efficiency in a discretionary expense centerit is simply the difference between the budgeted input and the actual input. It in no way measures the value of theoutput. if actual expense do not exceed the budget amount, the manager has lived within the budget however

,because by definition the budget does not purport to measure the optimum amount of spending we cannot say thatliving within the budgeted is efficient performance.

Profit Center

A responsibility centre is called a profit centre when the manager is held responsible for both costs (inputs) andrevenues (outputs) and thus for profit. Despite the name, a profit centre can exist in nonprofits organizations (thoughit might not be referred to as such) when a responsibility centre receives revenues for its services. A profit centre is abig segment of activity for which both revenues and costs are accumulated: A centre, whose performance ismeasured in terms of both - the expense it incurs and revenue it earns, is termed as a profit centre. The output of aresponsibility centre may either be meant for internal consumption or for outside customers. In the latter case, therevenue is realized when the sales are made. That is, when the output is meant for outsiders, then the revenue will bemeasured from the price charged from customers. If the output is meant for other responsibility centre, thenmanagement takes a decision whether to treat the centre as profit centre or not. In fact, any responsibility centre canbe turned into a profit centre by determining a selling price for its outputs. For instance, in case of a processindustry, the output of one process may be transferred to another process at a profit by taking into account themarket price. Such transfers will give some profit to that responsibility centre. Although such transfers do notincrease the Companys assets, they help in management control process.

Investment Centre


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An investment centre goes a step further than a profit centre does. Its success is measured not only by its income butalso by relating that income to its invested capital, as in a ratio of income to the value of the capital employed. Inpractice, the term investmentcentreis not widely used. Instead, the term profitcentreis used indiscriminately todescribe centers that are always assigned responsibility for revenues and expenses, but may or may not be assignedresponsibility for the capital investment. It is defined as a responsibility centre in which inputs are measured in termsof cost / expenses and outputs are measured in terms of revenues and in which assets employed are also measured. Aresponsibility centre is called an investment centre, when its manager is responsible for costs and revenues as well asfor the investment in assets used by his centre. He is responsible for maintaining a satisfactory return on investmenti.e. asset employed in his responsibility centre. The investment centre manager has control over revenues, expensesand the amounts invested in the centres assets. The manager of an investment centre is required to earn asatisfactory return. Thus, return on investment (ROI) is used as the performance evaluation criterion in aninvestment centre. He also formulates the credit policy, which has a direct influence on debt collection, and theinventory policy, which determines the investment in inventory. The Vice President (Investments) of a mutual fundscompany may be in charge of an Investment Centre. In the Investment Centre, the manager in charge is heldresponsible for the proper utilization of assets. He is expected to earn a satisfactory return on the assets employed inhis responsibility centre.

Budget Preparation.

The decision that management make about a discretionary expense budget are different from the decisions that itmakes about the budget for an engineered expense center. For the latter management decides whether the proposedoperating budget represent the cost of performing task efficiently for the coming period. management is not so muchconcerned with the magnitude of the task because this is largely determined by the actions of other responsibilitycenters, such as the marketing departments ability to generate sales. In formulating the budget for a discretionaryexpense center, however management principal task is to decide on the magnitude of the job that should be done.These tasks can be divided generally into two types continuing and special. Continuing task are those that continuefrom year to year for example financial statement preparation by the controllers office. Special tasks are one shotproject for example developing and installing a profit budgeting system in a newly acquired division. The techniquemanagement by objective is often used in preparing the budget for a discretionary expense center. Management byobjective is a formal process in which a budget purposes to accomplish specific tasks and state a mean for measuringwhether these tasks have been accomplished. There are two different approach to planning for the discretionaryexpense center increment budgeting and zero based review.

SET .9

Q1. Describe inherent difficulties creation of profit centres may cause and advantages possible?

Under which situation creation of profit centre is not advisable.

Under which situation creation of profit centre is not advisable

Decentralized decision making will force top management to rely more on management control reports than onpersonal knowledge of an operation, entailing some loss of control. If headquarters management is mere capable orbetter informed than the average profit center manager, the quality of decisions made at the unit level way be

reduced. Friction may increase because of arguments over the appropriate transfer price, the assignment of commoncosts, and the credit for revenues that were formerly generated jointly by two or more business units workingtogether.

Organization units that once cooperated as functional units may now be in competition with one another. Anincrease in profits for one manager may mean a decrease for another. In such situation a manager may fail to refersales leads to another business unit better qualified to pursue them; may hoard personnel or equipment that, from theoverall companys, standpoint, would be better off used in another unit; or may make production decisions that haveundesirable cost consequences for other units.


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Divisionalization may impose additional costs because of the additional management, staff personnel, and recordkeeping required, and may lead to task redundancies at each profit center.Competent general managers may not existin a functional organization because there may not have been sufficient opportunities for them to develop generalmanagement competence.

There may be too much emphasis on short-run profitability at the expense of long-run profitability. In the desire to

report high current profits, the profit center manager may skimp on R&D, training programs, or maintenance. Thistendency is especially prevalent when the turnover of profit center managers is relatively high. In thesecircumstances, managers may have good reason to believe that their actions may not affect profitability until afterthey have moved to other jobs. There is no completely satisfactory system for ensuring that optimizing the profits ofeach individual profit center will optimize the profits of the company as a whole.

Q2.What are the challenges faced in pricing corporate services provided to Business Unitsoperating as profit

centers?

Business Units as Profit Centers

Most business units are created as profit centers since managers in charge of such units typically control productdevelopment, manufacturing, and marketing resources. These managers are in a position to influence revenues and

costs and as such can be held accountable for the "bottom line." However, as pointed out in the next section, abusiness unit manager's authority may be constrained in various ways, which ought to be reflected in a profit center'sdesign and operation.

Constraints on Business Unit Authority

To realize fully the benefits of the profit center concept, the business unit manager would have to be as autonomousas the president of an independent company. As a practical matter, however, such autonomy is not feasible. If acompany were divided into completely independent units, the organization would lose the advantages of size andsynergy. Furthermore in delegating to business unit management all the authority that the board of directors hasgiven to the CEO, senior management would be abdicating its own responsibility. Consequently, business unitstructures represent trade-offs between business unit autonomy and corporate constraints. The effectiveness of abusiness unit organization is largely dependent on how well these trade-offs are made.

Constraints from Other Business Units.

One of the main problems occurs when business units must deal with one another. It is useful to think of managing aprofit center in terms of control over three types of decisions:

(1) The product decision (what goods or services to make and sell),

(2) The marketing decision (how, where, and for how much are these goods or services to be sold?), and

(3) The procurement or sourcing decision (how to obtain or manufacture the goods or services). If a business unitmanager controls all three activities, there is usually no difficulty in assigning profit responsibility and measuring

performance. In general, the greater the degree of integration within a company,

the more difficult it becomes to assign responsibility to a single profit center for all three activities in a givenproduct line; that is, if the production, procurement, and marketing decisions for a single product line are splitamong two or more business units, separating the contribution of each business unit to the overall success of theproduct line may be difficult.

Constraints from Corporate Management


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The constraints imposed by corporate management can be grouped into three types:

(1) Those resulting from strategic considerations,

(2) Those resulting because uniformity is required, and

(3) Those resulting from the economies of centralization.

Most companies retain certain decisions, especially financial decisions, at the corporate level, at least for domesticactivities. Consequently, one of the major constraints on business units results from corporate control over newinvestments. Business units must compete with one another for a share of the available funds. Thus, a business unitcould find its expansion plans thwarted because another unit has convinced senior management that it has a more

Attractive program. Corporate management .also imposes other constraints. Each business unit has a "charter" thatspecifies the marketing and/or production activities that it is permitted to undertake, and it must refrain fromoperating beyond its charter, even though it sees profit opportunities in doing so. Also, the maintenance of theproper corporate image may require constraints on the quality of products or on public relations activities.

Companies impose some constraints on business units because of the necessity for Uniformity. One-constraint isthat business Units must conform to corporate accounting and MCS This constraint is especially troublesome forunits that have been acquired from another company and that have been accustomed to using different systems.

Q.3) Write Short Notes on

1.Zero Based Budgeting

2.Internal Control\

Zero Based Budgeting:

Zero-based budgeting is a technique of planning and decision-making which reverses the working

process of traditional budgeting. In traditional incremental budgeting, departmental managers justify onlyincreases over the previous year budget and what has been already spent is automatically sanctioned.No reference is made to the previous level of expenditure. By contrast, in zero-based budgeting, everydepartment function is reviewed comprehensively and all expenditures must be approved, rather thanonly increases.

[1]Zero-based budgeting requires the budget request be justified in complete detail by each

division manager starting from the zero-base. The zero-base is indifferent to whether the total budget isincreasing or decreasing.

The term "zero-based budgeting" is sometimes used in personal finance to describe the practice ofbudgeting every dollar of income received, and then adjusting some part of the budget downward forevery other part that needs to be adjusted upward. It would be more technically correct to refer to thispractice as "active-balanced budgeting".

Advantages of Zero-Based Budgeting:

1. Efficient allocation of resources, as it is based on needs and benefits.

2. Drives managers to find cost effective ways to improve operations.

3. Detects inflated budgets.

4. Municipal planning departments are exempt from this budgeting practice.

5. Useful for service departments where the output is difficult to identify.
http://en.wikipedia.org/wiki/Budgetinghttp://en.wikipedia.org/wiki/Budgethttp://en.wikipedia.org/wiki/Zero_Based_Budgeting#cite_note-0http://en.wikipedia.org/wiki/Zero_Based_Budgeting#cite_note-0http://en.wikipedia.org/wiki/Zero_Based_Budgeting#cite_note-0http://en.wikipedia.org/wiki/Zero_Based_Budgeting#cite_note-0http://en.wikipedia.org/wiki/Budgethttp://en.wikipedia.org/wiki/Budgeting


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6. Increases staff motivation by providing greater initiative and responsibility in decision-making.

7. Increases communication and coordination within the organization.

8. Identifies and eliminates wasteful and obsolete operations.

9. Identifies opportunities for outsourcing.

10. Forces cost centers to identify their mission and their relationship to overall goals.

Disadvantages of Zero-Based Budgeting:

1. Difficult to define decision units and decision packages, as it is time-consuming and exhaustive.

2. Forced to justify every detail related to expenditure. The R&D department is threatened whereasthe production department benefits.

3. Necessary to train managers. Zero-based budgeting must be clearly understood by managers atvarious levels to be successfully implemented. Difficult to administer and communicate the budgetingbecause more managers are involved in the process.

4. In a large organization, the volume of forms may be so large that no one person could read it all.Compressing the information down to a usable size might remove critically important details.

5. Honesty of the managers must be reliable and uniform. Any manager that exaggerates skews the

results

Internal Control:

Internal control is defined as a process affected by an organization's structure, work and authority flows, peopleand management information systems, designed to help the organization accomplish specific goals orobjectives.[1]It is a means by which an organization's resources are directed, monitored, and measured. It playsan important role in preventing and detecting fraudand protecting the organization's resources, both physical(e.g., machinery and property) and intangible (e.g., reputation or intellectual property such as trademarks). Atthe organizational level, internal control objectives relate to the reliability of financial reporting, timely feedbackon the achievement of operational or strategic goals, and compliance with laws and regulations. At the specifictransaction level, internal control refers to the actions taken to achieve a specific objective (e.g., how to ensurethe organization's payments to third parties are for valid services rendered.) Internal control procedures reduce

process variation, leading to more predictable outcomes

Describing Internal Controls:

Internal controls may be described in terms of: a) the objective they pertain to; and b) the nature of thecontrol activity itself.

Objective categorization

Internal control activities are designed to provide reasonable assurance that particular objectives areachieved, or related progress understood. The specific target used to determine whether a control isoperating effectively is called the control objective. Control objectives fall under several detailedcategories; in financial auditing, they relate to particular financial statement assertions,

[5]but broader

frameworks are helpful to also capture operational and compliance aspects:

1. Existence (Validity): Only valid or authorized transactions are processed (i.e., no invalidtransactions)

2. Occurrence (Cutoff): Transactions occurred during the correct period or were processed timely.

3. Completeness: All transactions are processed that should be (i.e., no omissions)

4. Valuation: Transactions are calculated using an appropriate methodology or are computationallyaccurate.
http://en.wikipedia.org/wiki/Management_information_systemhttp://en.wikipedia.org/wiki/Internal_control#cite_note-0http://en.wikipedia.org/wiki/Internal_control#cite_note-0http://en.wikipedia.org/wiki/Internal_control#cite_note-0http://en.wikipedia.org/wiki/Fraudhttp://en.wikipedia.org/wiki/Internal_control#cite_note-4http://en.wikipedia.org/wiki/Internal_control#cite_note-4http://en.wikipedia.org/wiki/Internal_control#cite_note-4http://en.wikipedia.org/wiki/Internal_control#cite_note-4http://en.wikipedia.org/wiki/Fraudhttp://en.wikipedia.org/wiki/Internal_control#cite_note-0http://en.wikipedia.org/wiki/Management_information_system


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5. Rights & Obligations: Assets represent the rights of the company, and liabilities its obligations, asof a given date.

6. Presentation & Disclosure (Classification): Components of financial statements (or otherreporting) are properly classified (by type or account) and described.

7. Reasonableness-transactions or results appear reasonable relative to other data or trends.

Activity categorization

Control activities may also be described by the type or nature of activity. These include (but are notlimited to):

Segregation of duties - separating authorization, custody, and record keeping roles to limit risk of fraud orerror by one person.

Authorization of transactions - review of particular transactions by an appropriate person.

Retention of records - maintaining documentation to substantiate transactions.

Supervision or monitoring of operations - observation or review of ongoing operational activity.

Physical safeguards - usage of cameras, locks, physical barriers, etc. to protect property.

Analysis of results, periodic and regular operational reviews, metrics, and otherkey performance

indicators (KPIs).

IT Security - usage of passwords, access logs, etc. to ensure access restricted to authorized personnel. S

Q4 .Veena Pvt. Ltd., a small multiproduct company is taken over by a multinational company ( e.g.

Hindustan Lever.) What changes in the control system would you expect and why?

Since Veena is a small multiproduct company it would require changes in control system which would be related totransfer pricing a, as this company would generally provide inputs to HUL. Thus the domestic operations generallyinvolve transfer of goods and services only In view of this difference many other considerations, in addition to thecriteria used in domestic operations for the determination of transfer price, are involved. These include:

(a) Fair Price: This is an important factor one needs to consider while determining the transfer price for foreign

operations. Companies that enter into joint ventures must ensure that the transfer price charged is fair. If suchcompanies charge a

mcs april 2011 paper

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